MARKET DATELINE

PP 7767/09/2010(025354)

8 September 2010
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Malaysia

Economic Outlook

Slowing Growth, But Recovery On Track

Executive Summary
‹ The economy softened to 8.9% yoy in the 2Q, after hitting a peak of +10.1% in the 1Q.
We expect the growth to decelerate further in the 2H of the year and this will likely continue
into 2011, on the back of a slowdown in exports. The surge in the ringgit in a short span
of time, coupled with the removal of subsidies and rising borrowing costs which happened
at around the same time, is likely to slow down exports and business spending further.
This, in turn, will likely affect job prospects and consumer spending as well. Consequently,
we expect real GDP growth to normalise to around 5.0% in 2011, after a strong rebound
to an estimate of +7.3% in 2010.

‹ Developed nations’ policies have titled toward loosening bias given prospects of a sharper
slowdown in the global economy. We believe policy tightening in Asia will slow down as
well. Furthermore, the strengthening of regional currencies against the US dollar will
naturally dampen these countries’ exports, resulting in indirect tightening effect on the
economy. This is especially the case for Malaysia. As a whole, we expect the country’s
real exports to slow down to 7.6% in 2011, from an estimate of +11.7% in 2010.

‹ Domestic demand will likely soften in 2011 as well, on the back of weaker consumer and
business spending as well as public investment. Growth, however, will likely be resilient
due to the sustained increase in consumer spending, on account of rising consumerism and
high savings. Fiscal consolidation will likely continue into 2011 and the Federal Government
is projected to cut its budget deficit to 4.2% of GDP or RM34.5bn during the year.

‹ The current account surplus in the balance of payments is envisaged to widen as the
economy slows. This will provide an underlying support to the ringgit, which will likely
fluctuate at between RM3.10-3.20/US$ for the rest of this year, before settling at around
RM3.10/US$ in 2011.

‹ Inflation will likely trend up to an average of 2.8% in 2011, from an estimate of +2.0%
in 2010, on the back of a gradual reduction in subsidies by the Government. Meanwhile,
Bank Negara Malaysia is expected to resume its policy normalisation in 1H 2011 and the
overnight policy rate will likely be raised by 50-75 basis points to 3.25-3.50%.

Peck Boon Soon

Please read important disclosures at the end of this report. (603) 9280 2163
bspeck@rhb.com.my
Slowing Growth, But Recovery On Track

The economy softened to 8.9% yoy in the 2Q, after hitting a peak of +10.1% in
the 1Q. We expect the growth to decelerate at a faster pace in the 2H of the year
and this will likely continue into 2011, on the back of a slowdown in exports. The
surge in the ringgit in a short span of time, coupled with the removal of subsidies
and rising borrowing costs which happened at around the same time, is likely to
slow down exports and business spending further, as they adjust to higher cost
structure. This, in turn, will likely affect job prospects and consumer spending as
well. Consequently, we expect real GDP growth to normalise to around 5.0% in
2011, after a strong rebound to an estimate of +7.3% in 2010. Meanwhile, the
current account surplus in the balance of payments is projected to widen as the
economy slows. This will continue to provide an underlying support to the ringgit,
which we expect it to fluctuate at around RM3.10-3.20/US$ for the rest of the
year before settling at RM3.10 in 2011. Inflation will likely trend up to an average
of 2.8% in 2011, on the back of a gradual removal of subsidies. The Central Bank
will likely resume its policy normalisation in 1H 2011, after taking a pause for the
rest of this year.

Economic Growth Likely To Normalise To Around 5.0% In

2011

The slowdown in the world’s major economies, from the US to Japan and China, The slowdown in the world’s
has become more widespread since the 2Q, after a strong rebound from the major economies, from the
worst recession since the world war II. Indeed, the latest economic data releases US to Japan and China, has
suggest that the growth in these countries will likely soften further in the 2H of the become more widespread
year and extend into 1H 2011. Also, effect of the dissipating global stimulus spending
since the 2Q
will also likely be felt in the 2H. Already, the annualised personal consumption
expenditure in the US moderated further in July, while manufacturing activities in
Japan and China turned softer in July-August. Although the Euroland, India and
Indonesia’s economies picked up in the 2Q, their economic activities are likely to
have peaked and will likely soften going forward, in our view. In particular, the
Euroland’s economy will likely feel the pinch when the austerity measures start to bite
in the 2H of the year.

Back on the home front, the economy softened to 8.9% yoy in the 2Q, after hitting a We expect Malaysia’s real
peak of +10.1% in the 1Q. We expect the growth to decelerate further in the 2H of the GDP growth to normalise
year and this will likely continue into 2011, on the back of a slowdown in exports. The to around 5.0% in 2011,
surge in the ringgit in a short span of time, coupled with the removal of subsidies and
after a strong rebound to
rising borrowing costs which happened at around the same time, is likely to squeeze
an estimate of +7.3% in
companies’ earning and make the business environment more challenging to operate,
2010
especially for exporters. As a result, businesses are likely to turn cautious in recruiting
workers and for expansion, in our view. This, in turn, will likely affect job prospects
and consumer spending as well. Already, the country’s exports slowed down further
in July, the fourth consecutive month of slowing down and the slowest pace of growth
in eight months. Consequently, we expect real GDP growth to normalise to
around 5.0% in 2011, after a strong rebound to an estimate of +7.3% in 2010.

Developed Nations Ready To Ease Policies, If Situation

Warrants

Sensing the renewed weakness in the economy, the US Federal Reserve has acted The US Federal Reserve
fast and shifted its policy towards a loosening bias on 10 August whereby it has shifted its policy
pledged to roll over Treasury securities and reinvest proceeds from mortgage-related towards a loosening bias
securities as and when it matures to prevent its balance sheet from shrinking. While
the direct effect of the Fed’s move is not significant, it shows its willingness and ability
to go further if economic conditions worsen. This will likely prevent the US economy
from falling back into a recession, in our view, even though it is slowing down
and the recovery will likely be uneven and gradual.

ECONOMIC 2 OUTLOOK
Similarly, the Bank of Japan (BOJ) conducted an emergency meeting on 30 August The Bank of Japan stepped
and stepped up its monetary stimulus for the first time since March by up its monetary stimulus
expanding a bank-loan programme by ¥10 trn (US$116bn) to a total of ¥30 trn, after for the first time since
the economy’s recovery weakened and the yen surged to a 15-year high recently.
March by expanding a
The strong gain in yen at a time when global demand is weakening will likely hurt the
bank-loan programme in
country’s exports and the export-dependent Japanese economy the most. We believe
August
Japan will likely do more to help the economy, particularly in addressing the
sharp rise in yen. It is an irony that investors still prefer to buy the yen even though
Japan’s economic fundamentals are weaker than its counterparts such as the US or
the Euroland. The most prominent among the reasons why investors prefer to buy
yen is that while it may not be the best investment in the world, it beats the alternatives,
offering a relative safe haven in a treacherous global economy.

Meanwhile, the Euroland has already eased its policies in May by reactivating its The European Central Bank
unlimited 3-month fixed-rate loan offers to financial institutions and unveiling an said that it will extend its
unprecedented emergency stabilisation loan package of as much as €750bn (US$962bn) offer of unlimited liquidity
when the sovereign debt crisis in the region deepened. These, coupled with the to banks into 2011
austerity measures undertaken by the highly-indebted nations in the region and the
subsequent release of the stress test results in late July, have successfully stopped
the sovereign debt crisis from deepening. Although the Euroland has yet to feel the
effect of the austerity drive, it will likely come back to haunt the economy and the
euro towards the end of the year. This suggests that monetary conditions are
likely to remain loose in the region in the near term. Already, the European
Central Bank (ECB) said that it will extend its offer of unlimited liquidity to
banks into early 2011, while keeping its key policy rate at a record low of 1.0% for
the 17th straight month in September. Earlier in May, the ECB has committed to lend
banks unlimited cash until at least 12 October.

Policy Tightening In Asia Likely To Slow Down

Asian central banks, on the other hand, continued to normalise/tighten monetary Asian central banks, on the
conditions in recent months. Singapore for instance, tightened its mortgage policy other hand, continued to
on 30 August. The curbs marked the third set of major measures Singapore has tighten policies in recent
taken in 12 months to cool the property market. Similarly, Hong Kong tightened its months...
mortgage lending rules to cool down the property market in early August. Thailand
also started to normalise its monetary policy and it raised its key policy rate for the
second time in August to 1.75% given that its interest rates are still too low, while
India raised its benchmark interest rate for the fourth time this year to 5.75% in July
in a move to curb rising inflation. In the same vein, South Korea raised its key
policy rate in July by 25 basis points to 2.25%, before taking a pause in August. The
country’s central bank indicated that it plans to raise it again in September given that
its interest rates are still low.

China, on the other hand, has introduced a series of tightening measures to cool ... but most central banks
down its property market and rapid credit expansion since last year. The measures are likely to slow down or
have yielded positive results and we believe the country will unlikely tighten further pause in view of the risk of
for the rest of this year and investors are now expecting the authorities to ease back. a sharper slowdown in the
Similarly, we believe most central banks in the region are likely to slow down
global economy
their policy tightening or pause in view of the risk of a sharper slowdown in the
global economy.

Malaysia will likely follow suit after it took a pause and maintained its overnight Malaysia has also taken a
policy rate (OPR) at 2.75% on 2 September. Bank Negara Malaysia (BNM) raised its pause and will likely
OPR three times this year and by a total of 75 basis points. We believe BNM is likely resume its policy
to have done with its interest rate hikes for the rest of this year. The Central Bank, normalisation in 1H 2011
however, will likely resume its policy normalisation in 1H 2011 and we expect
the OPR to be brought to a more neutral level of 3.25-3.50%.

Furthermore, regional currencies have appreciated quite sharply against the US dollar Strengthening of regional
due to inflow of foreign capital in search for higher returns in recent months. The currencies will dampen
strengthening of their currencies will naturally dampen these countries’ exports, resulting in
exports, resulting in indirect tightening effect on the economy (see Charts 1 & 2). indirect tightening effect

ECONOMIC 3 OUTLOOK
This is especially the case for Malaysia as the ringgit has appreciated by 9.9% against
the US dollar year-to-date, one of the strongest gains in the region after the yen.

Chart 1 Chart 2
Ringgit Gained The Most Against Chinese Yuan Hardly
The US Dollar In The Region Move Despite Adopting A More
Flexible Exchange Rate
% YTD Vis-a-Vis US$ % YTD Vis-a-Vis US$
12 12
10.3
10.0
10
10

8
8 7.3
6
6

4.2 4.1 4.4 4

4
2
0.5 -1.3 0.1
2 -0.3
0

0 -2
MYR SGD THB Peso Rupiah Yen Yuan KRW TWD INR

Signs Of Slowing Global Growth Become More Apparent

Meanwhile, signs of slowing global growth are becoming more apparent. Already, Signs of slowing global
global manufacturing (see Chart 3) activities have slowed down for the fourth growth are becoming more
straight month in August and it was the slowest pace of increase in nine months. In apparent
particular, manufacturing new orders weakened to the slowest pace of growth in 14
months and since it turned into positive growth in July 2009, indicating that global
manufacturing activities are likely to moderate further in the months ahead. Similarly,
global services activities slowed down for the fourth consecutive month in August.
In the same vein, the OECD composite leading indicator, has been trending lower
for the last few months (see Chart 4), indicating that OECD countries’ economies are
likely to expand at a slower pace in the months ahead.

Chart 3 Chart 4
Global Manufacturing And OECD Composite Leading
Services Activities Heading South Indicator Points To A Slowing
Economic Growth
Index PMI % 12-mth annualised rate of change
65 Services 30

25
➤

60
20

55 15

10
➤

50
5
45 0

40
PMI -5
Manufacturing
-10
Total OECD Japan US Euro area China
35
-15

30 -20
05 06 07 08 09 10 00 01 02 03 04 05 06 07 08 09 10

In the US, the economy grew at a weaker-than-expected annualised rate of 1.6% in The US economy is
the 2Q. Also, personal consumption expenditure (PCE) slowed down to 1.7% in July, projected to moderate to
from +2.0% in June and the peak of +2.5% in April-May, suggesting that consumer 2.8% in 2011, from +3.0%
spending is losing momentum (see Chart 5). However, the PCE grew m-o-m for the estimated for 2010
third month out of four months, indicating that consumer spending is likely to remain
resilient in the months ahead in supporting the US economy. Indeed, personal income
has been on the rise given that the economy has been creating jobs for the last eight
consecutive months even though it has weakened somewhat. As it stands, a total of
67,000 jobs were created by the private sector in August, albeit lower than 107,000
jobs created in July but off a high of 241,000 jobs recorded in April (see Chart 6). As

ECONOMIC 4 OUTLOOK
a whole, the US economy is projected to moderate to 2.8% in 2011, from
+3.0% estimated for 2010.

Chart 5 Chart 6
US: Consumer Spending Slowing US: The Economy Is Still Creating
But Resilient Jobs, Albeit At A More Moderate
Pace
% yoy
(Personal consumption expenditure) (‘000)
5
600
4
400
3
200
2
0
1
-200
0
-400
-1

-2 -600

-3 -800

-4 -1000
2005 2006 2007 2008 2009 2010 05 06 07 08 09 10

Similarly, Japan’s manufacturing activities weakened to the slowest pace in 14 months Japanese economy will
in August and exports eased for the fifth straight month in July (see Chart 7), suggesting likely remain weak and the
that the export-dependent Japanese economy will likely remain weak. In the Euroland’s economy is
same vein, the Euroland’s economy is likely to have peaked in the 2Q, as its likely to have peaked in the
export engine, which powered the 2Q’s GDP growth, has started to moderate. As a
2Q
result, manufacturing and services activities have begun to trend down (see Chart 8).

Chart 7 Chart 8
Japan: Manufacturing Activities Euroland: Manufacturing And
And Exports Weakening Services Activities Moderating
Index PMi % yoy Index
60 manufacturing 60
65
(LHS)
PMI
50 40 60
Services

55
➤
40 20
➤

50
30 0

45
20 -20
Exports 40
(RHS)
10 -40
35
PMI Manufacturing ➤
0 -60
30
2007 2008 2009 2010
05 06 07 08 09 10

In China, retail sales moderated for the second consecutive month to 17.9% yoy in China’s economy is likely to
July and fixed-asset investment in urban areas slowed down to 24.9% yoy in January- moderate further in the 2H
July, from the corresponding period of +32.9% in 2009 (see Chart 9). Similarly, of the year and in 2011,
industrial production headed south for the fourth straight month to 13.4% yoy in July,
after recording a slower
while growth of money supply has been easing since December last year. Although
growth of +10.3% yoy in
the PMI manufacturing index rebounded in August, manufacturing activities remained
the 2Q
weak. As a whole, China’s economy is likely to slow down further in the 2H of
the year and in 2011, after recording a more moderate growth of +10.3% yoy in the
2Q.

ECONOMIC 5 OUTLOOK
 Chart 9
China: Fixed-Asset Investment, Retail Sales And
Industrial Production Softening
% yoy Retail sales % yoy
Ipi (LHS)
25 60
(LHS)

➤
50
20

➤
40
15
30
10

➤
20

5
Fixed asset 10

0 0
00 01 02 03 04 05 06 07 08 09 10

Exports Of E&E Products Will Likely Moderate

In tandem with a more moderate growth in the global economy, demand for electrical In tandem with a slowdown
& electronic (E&E) products, which accounts for about 45% of Malaysia’s total exports in global demand, we
in 2009, and other non-E&E manufactured goods is likely to soften in 2011. Already, expect the country’s real
worldwide semiconductor sales eased to 37.0% yoy in July, from +42.6% in June and exports to slow down to
after reaching a high of +59.9% in March. This suggests that a sharp rebound in sales
7.6% in 2011
due to a spike-up in demand and inventory rebuilding are normalising. As a whole, in
tandem with a slowdown in the global demand, we expect the country’s real exports
to slow down to 7.6% in 2011, from an estimate of +11.7% in 2010.

Domestic Demand Will Likely Be Resilient

While exports are likely to slow down, domestic demand will likely be resilient, on the We expect domestic
back of a sustained increase in consumer and business spending, albeit at a more demand to hold up in 2011,
moderate pace. As a result, we expect domestic demand to hold up at 5.5% in albeit at a more moderate
2011, albeit at a more moderate pace, compared with +5.6% estimated for 2010 and pace
-0.5% in 2009 (see Table 1). In line with a weaker export growth, which will likely
translate into a slowdown in production and employment, consumers are likely to turn
cautious in spending. As a result, consumer spending is projected to moderate to
5.4% in 2011, but remain relatively strong compared with +5.6% estimated for 2010.
Apart from weaker job prospects, the reinstatement of employees’ contribution to the Consumer spending is
Employees Provident Fund (EPF) back to 11%, from 8% when it was cut in 2009, will projected to moderate in
likely affect consumer spending somewhat. Consumer spending, however, will likely 2011
remain resilient, on the back of high savings and rising consumerism.

Table 1
GDP By Demand Aggregate (2000=100)
2007 2008 2009 2009 2010 2010(e) 2011(f)

2Q 3Q 4Q 1Q 2Q
% Growth in Real Terms

GDP 6.5 4.7 -1.7 -3.9 -1.2 4.4 10.1 8.9 7.3 5.0
Consumption:
Private 10.5 8.5 0.7 0.3 1.3 1.6 5.1 7.9 5.6 5.4
Public 6.6 10.7 3.1 1.5 9.4 0.7 6.3 6.9 -0.4 4.5
Total investment 9.4 0.7 -5.6 -9.6 -7.9 8.2 5.4 12.9 9.7 6.3
Private 13.1 1.0 -17.2 n.a n.a n.a n.a n.a 8.6 7.8
Public 5.3 0.5 8.0 n.a n.a n.a n.a n.a 10.8 4.9
Goods & services:
Exports 4.1 1.6 -10.4 -17.9 -12.9 6.0 19.3 13.8 11.7 7.6
Imports 5.9 2.2 -12.3 -19.4 -13.2 7.0 27.5 21.9 16.5 8.4
Agg.domestic demand 9.6 6.8 -0.5 -2.2 0.1 2.8 5.3 9.0 5.6 5.5

(f): RHBRI's forecasts (e): RHBRI’s estimates

ECONOMIC 6 OUTLOOK
Similarly, we expect businesses to slow down their investment due to economic Businesses will slow down
uncertainties. In addition, the surge in the ringgit in a short span of time, coupled with their investment due to
the removal of subsidies and rising borrowing costs which happened at around the economic uncertainties
same time, is likely to squeeze companies’ earning and make the business environment
more challenging, especially for exporters. As a result, the private investment is
envisaged to soften to 7.8% in 2011, after recovering to +8.6% estimated for 2010.
In the same vein, public investment is projected to expand at a slower pace of
4.9% in 2011, after two consecutive years of strong growth, as the previous two
years’ growth was boosted by the Government’s stimulus spending which will unlikely
be repeated next year. Consequently, we expect fixed capital formation to ease
to 6.3% during the year, from +9.7% estimated for 2010. A stronger growth in public Public investment is

consumption, however, will likely help mitigate the slowdown. We expect public projected to expand at a
consumption to grow by 4.5% in 2011, after slipping into a contraction of 0.4% estimated slower pace in 2011
for 2010.

Further Cut In Budget Deficit Likely

The budget deficit reached a high of 7.0% of GDP in 2009, the highest in 22 years, We expect the fiscal
caused mainly by the implementation of two economic stimulus packages to cushion consolidation to continue
the economy from the severe global recession. However, the Government has begun into 2011 and the
to consolidate its fiscal position in 2010. As a result, the Government expects its Government will likely cut
budget deficit to be reduced to 5.3% of GDP or RM40.3bn in 2010. We expect the its budget deficit to 4.2%
fiscal consolidation to continue into 2011 and the Government will likely
of GDP during the year
cut its budget deficit further to 4.2% of GDP or RM34.5bn during the year
(see Table 2). This is likely to be carried out through a reduction in the Government’s
expenditure, particularly development spending, as we believe it is not ready to
broaden its tax collection via an introduction of the Goods & Services Tax (GST).

We believe the Government is likely to cut its gross development expenditure The Government is likely to
by about 19% in 2011. This will bring the total development expenditure to cut its gross development
RM43.8bn, compared with an estimate of RM54.2bn in 2010. During the year, we expenditure by about 19%
believe the Government will likely shift its expenditure on “physical hardware” to in 2011 and shift its
“soft infrastructure” where the latter’s share has been raised to 40% of its total
expenditure to build “soft
development spending in the 10th Malaysia Plan (10MP), from 22% in the 9MP. This
infrastructure”
implies that construction companies, particular small- and medium-sized contractors
that are involved in building construction and utilities works, are likely to be affected,
in our view. On the other hand, we expect companies that provide training & upgrading
of skills to benefit from the Government’s development spending in 2011.

Table 2
FEDERAL GOVERNMENT FINANCIAL POSITION

2008 2009 20101(e) 2011(f) 2010(e) 2011f)

(RM bil) (%, change)

Revenue 159.8 158.6 160.9 167.3 1.4 4.0

Operating Expenditure 153.5 157.1 147.5 158.6 -6.1 7.5
Current balance 6.3 1.5 13.4 8.7
Gross development expenditure 42.8 49.5 54.2 43.8 9.5 -19.2
Less : Loan recoveries 1.0 0.6 0.5 0.6
Net development expenditure 41.9 49.0 53.7 43.2 9.6 -19.5
Overall balance -35.6 -47.4 -40.3 -34.5
% to GDP -4.8 -7.0 -5.3 -4.2

1
Budget estimate, excluding 2009 tax measures
e : Estimates f : RHBRI’s Forecasts
Source : MOF's Economic Report 2009/2010, EPU

ECONOMIC 7 OUTLOOK
After a sharp cutback in operating expenditure (OE) in 2010, we do not expect the We expect the
Government to do the same in 2011. Instead, we expect the Government to raise Government to raise its OE
its OE by 7.5% in the 2011 Budget, in tandem with a pick-up in its revenue as the in 2011 , in tandem with a
economy returns to growth. This is likely to be reflected in a pick-up in its expenditure
pick-up in its revenue as
on emoluments, debt servicing, supplies & services, grants & transfers and other
the economy returns to
expenditure. These are likely to be partially offset by a slight drop in subsidies.
growth

Manufacturing And Services Sectors To Lead The Slowdown

On the supply side, the manufacturing and services activities are likely to lead the The manufacturing sector
slowdown, in line with weaker trade activities, while business and consumer spending growth is projected to
are likely to moderate as well. Also, construction activities will likely ease but will ease, on account of a
likely be mitigated by a pick-up in agriculture and mining output during the year. slowdown in exports and
Value added in the manufacturing sector is projected to ease to 8.0% in 2011,
domestic demand
after picking up to +12.3% estimated for 2010 (see Table 3), on account of a slowdown
in exports and domestic demand. Already, output of the export-oriented industries
moderated to 12.3% yoy in June, from +16.8% in May and after reaching a high of
+21.3% in March. This was on account of a moderation in the production of E&E
products; wood & wood products; rubber products; petroleum products; and paper,
pulp & board products. These were, however, mitigated by a pick-up in the production
of chemical products and a smaller decline in the production of textile & apparels
during the period. Similarly, output of domestic-oriented industries softened to 16.6%
yoy in June, the slowest in four months and after reaching a high of +24.0% in May.
This was due to a slowdown in the production of construction-related materials,
particularly iron & steel and fabricated metal products, consumer-related products
such as food, and transport equipment.

Table 3
GDP By Industrial Origin At 2000 Prices
2007 2008 2009 2009 2010 2010(e) 2011(f)
2Q 3Q 4Q 1Q 2Q
% Growth in Real Terms

GDP 6.5 4.7 -1.7 -3.9 -1.2 4.4 10.1 8.9 7.3 5.0

Agriculture 1.3 4.3 0.4 0.4 -0.4 5.9 6.8 2.4 3.3 3.5
Mining 2.0 -2.4 -3.8 -3.5 -3.6 -2.8 2.1 1.9 2.1 2.3
Manufacturing 2.8 1.3 -9.4 -14.5 -8.6 5.0 17.0 15.9 12.3 8.0
Construction 7.3 4.2 5.8 4.5 7.9 9.3 8.7 4.1 4.2 2.8
Services 10.2 7.4 2.6 1.7 3.4 5.2 8.5 7.3 6.3 4.6

(f): RHBRI's forecasts (e): RHBRI’s eatimates

Similarly, we envisage the broad services sector to expand at a more moderate Services activities are
pace of 4.6% during the year, after a rebound to an estimate of +6.3% in 2010, as likely to moderate, as busi-
businesses and consumers turn cautious in spending and trade activities slow. The nesses and consumers turn
slowdown in services activities will likely be reflected in slower increases in activities cautious
in utilities, transport & storage, communications and real estate & business sub-sectors.
Similarly, a slowdown in consumer spending and tourist arrivals will likely result in a
slowdown in wholesale & retail trade and accommodation & restaurants sub-sectors.
In the same vein, government services will likely slacken during the period due to
fiscal consolidation. Activities in finance & insurance sub-sector, though moderating,
will likely be resilient in 2011.

Construction activities are also likely to slow down to 2.8% in 2011, after Construction sector is also
moderating to +4.2% estimated for 2010 and compared with +5.8% in 2009, as growth projected to slow down, as
in the previous two years was boosted by the Government’s stimulus spending. As a growth in the previous two
result, the civil engineering sub-sector is projected to grow at a more moderate pace years was boosted by the
during the year. Similarly, construction activities in the residential property sub-sector Government’s stimulus
will likely ease somewhat in 2011, after picking up for about one-and-a-half years,
spending

ECONOMIC 8 OUTLOOK
while construction activities in non-residential property sub-sector are still ongoing.
As it stands, new permits for sales and advertising of houses strengthened to 22.6%
yoy in 1H 2010, from +12.3% in 2009, while renewal permits fell by 21.0% yoy, after
rising by 15.0% during the same period. In the same vein, housing approvals by the
Ministry of Housing and Local Government gained another 10.3% yoy in 1H 2010,
after picking up by 4.2% in 2009.

The agriculture sector, however, is envisaged to strengthen to 3.5% during Agriculture output is envis-
the year, after a gain of 3.3% estimated for 2010. This will likely be driven by a pick- aged to strengthen due
up in palm oil production during the year, after going through two consecutive years mainly to a pick-up in palm
of lacklustre performance. In 1H 2010, palm oil production grew modestly by 0.7%
oil production
yoy, after slipping into a contraction of 1.0% in 2009 and from +12.1% in 2008.
Slower growth in the production of rubber and saw logs, however, will likely offset
part of the gain. In 1H 2010, rubber and saw logs output bounced back strongly to
increase by 17.4% and 25.0% yoy respectively, after two consecutive years of
contraction in 2008-09. Meanwhile, the non-commodity sub-sector such as fisheries,
livestock and crops will contribute to growth as well, on the back of the implementation
of various projects by the Government.

Similarly, we expect mining output to inch up to 2.3% in 2011, from +2.1% Mining output will likely inch
estimated for 2010. This is mainly on account of a pick-up in the production of liquefied up due to higher LNG
natural gas (LNG) due to higher demand. Already, LNG output rebounded to increase output and a smaller
by 9.3% yoy in 1H 2010, from -3.7% in 2009 and +0.1% in 2008. This will likely be decline in crude oil
aided by a smaller drop in crude oil production, which contracted by a smaller magnitude
production
of 2.8% yoy in 1H 2010, compared with -4.1% in 2009 and +0.8% in 2008.

Softer Monetary And Loan Growth Envisaged In 2011

The broader money supply, M3, moderated to +8.1% yoy in July, from +8.8% in June M3 growth will likely
and after reaching a recent high of 9.3% in May. This was the second straight month moderate in 2011, but the
of easing, suggesting that the underlying economic activities have softened. The monetary policy will likely
slowdown was in line with a slowdown in government operations, as the Government’s be supportive of economic
stimulus spending is dissipating. This was made worse by a slowdown in demand for
growth
funds by the private sector, on account of a more moderate loan growth and a slower
increase in the issuance of securities. These were, however, mitigated by a pick-up in
net external operations, on account of an inflow of foreign portfolio funds. Going
forward, we expect M3 growth to moderate to around 8.0% in 2011, from +8.7%
estimated at end-2009, in line with a slowdown in economic activities. Despite the
softer growth, monetary policy will likely remain supportive of economic
growth in 2011.

Similarly, loan growth eased to 11.9% yoy in July, after rising to a high of +12.5% in We expect the banking
June. This was the first easing after three consecutive months of picking up, suggesting system’s loans to ease in
that loan growth is beginning to soften in line with a more moderate increase in 2011, in tandem with the
economic activities. This was attributed to a slowdown in corporate loans, which was slowdown in the economy
mitigated by a pick-up in household loans during the period. Our estimate shows that
corporate loans eased to 14.0% yoy in July, after reaching a peak of 15.6% in June.
This was the slowest pace of growth in three months due mainly to a slowdown in
loans given to the agriculture, utilities, construction, real estate and education &
healthcare sectors. These were, however, mitigated by a pick-up in loans extended to
the mining & quarrying and manufacturing industries. Household loans, on the
other hand, strengthened to +13.2% yoy in July, the highest in more than three years
and compared with +12.9% in June. This was due to a pick-up in loans extended for
the purchase of passenger cars and houses as well as for credit cards during the
month. Going forward, we expect the banking system’s loans to moderate to around
8.5% in 2011, from 10.5% estimated for 2010, in tandem with the slowdown in the
economy.

In terms of asset quality, the 3-month net impaired loan ratio of the banking system
remained stable at 2.2% of total loans for the third consecutive month in July, after
rising from 1.9% in March and compared with a low of 1.8% in December last year.
The slight uptick in net impaired loan ratio might have been caused by a deterioration

ECONOMIC 9 OUTLOOK
in asset quality system wide due to the lagged effect of the recession in 2009, and The banking system’s 3-
banks adopting the FRS139. According to Bank Negara Malaysia (BNM), beginning month net impaired loan
Jan 2010, loans are reported based on the FRS139, although adoption by the various ratio is projected to ease
banks would still depend on their respective FYE. Going forward, we expect the
slightly to 2.0% by end-
banking system’s 3-month net impaired loan ratio to ease slightly to 2.0% by
2011
end-2011, from 2.2% estimated for end-2010.

Sustained Large Current Account Surplus Which Will

Remain Supportive Of The Ringgit

In tandem with a slowdown in the economy, we expect merchandise trade balance to The current account
record a larger surplus during the year. At the same time, we envisage deficit in the surplus of the balance of
services account to narrow due to lower payment for transportation charges as imports payments is projected to
slow down. These, however, will likely be offset partially by a widening deficit in the widen marginally in 2011
income account during the year, as repatriation of profits by non-resident controlled
companies is likely to remain large, while Malaysian corporations will likely bring back
less profits into the country. Repatriation of salaries and wages by foreign workers,
on the other hand, is likely to remain stable during the year. As a whole, we expect
the current account surplus of the balance of payments to widen marginally to
around RM98.6bn or 12.4% of GNI in 2011, from a surplus of RM97.1bn or 13.0%
of GNI estimated for 2010 (see Table 4). This will help to build up the country’s
foreign exchange reserves and fuel domestic liquidity in the financial system. Indeed,
excess liquidity (including repos) mopped up by the Central Bank from the banking
system inched up to RM218.1bn at end-August, from RM214.4bn in mid-August 2010
and compared with RM223.3bn at end-2009.

Table 4
Balance Of Payments

2008 2009 2009 2010 2010(e) 2011(f)

2Q 3Q 4Q 1Q 2Q

(RMbn)

Current account 129.5 112.1 28.0 25.4 27.4 30.4 16.2 97.1 98.6
(% of GNI) (18.1) (16.8) n.a n.a n.a n.a n.a (13.0) (12.4)
Goods 170.6 141.8 33.2 33.4 37.9 45.0 30.8 143.1 145.2
Services 0.2 4.7 1.5 0.6 -0.1 -0.1 -0.4 -1.4 -0.9
Income -23.7 -14.6 -2.9 -1.7 -5.6 -8.9 -8.6 -26.1 -27.2
Current transfers -17.5 -19.6 -3.9 -6.8 -4.8 -5.6 -5.6 -18.5 -18.5

Capital account 0.6 -0.2 -0.0 -0.0 -0.0 -0.1 -0.1 0.0 0.0

Financial account -118.5 -80.2 -22.3 -9.4 -17.4 -19.5 0.8 -53.0 -45.5
Errors & omissions* -29.9 -17.9 -3.5 -4.5 -13.0 -30.5 -18.8 -50.0 -25.0
Overall balance -18.3 13.8 2.1 11.5 -3.0 -19.6 -1.9 -5.9 28.1

Outstanding reserves^ 317.4 331.4 322.9 334.4 331.4 311.8 309.8 325.4 353.5
(US$)^ 91.5 96.7 91.5 96.0 96.7 95.3 94.8 94.9 103.7

(f): RHBRI's forecasts (e): RHBRI’s estimates ^As at end-period

*Reflect mainly revaluation gains/losses from Ringgit depreciation/appreciation and statistical discrepancies

In the same vein, the financial account will likely record a smaller outflow of The financial account will
capital, as Malaysian investors turn cautious on the back of rising economic likely record a smaller
uncertainties. As a result, we envisage outflow of capital to narrow to around RM45.5bn outflow of capital in 2011
in 2011, from -RM53.0bn estimated for 2010. This is on account of a slowdown in
Malaysians’ other investments abroad, as they turn cautious given prospects of a
slowdown in the global economy. Similarly, we expect outward direct investment to
slow down, leading to a net inflow of foreign direct investment (FDI) during the year,
a turnaround from a smaller net outflow estimated for 2010. These, however, will
likely be offset partially by a smaller inflow of portfolio investment in 2011, as economic
growth in the investing country turns softer.

ECONOMIC 10 OUTLOOK
As a whole and after taking into account a smaller deficit in errors & omissions, the The overall balance of
overall balance of payments is projected to record a surplus of around RM28.1bn payments is projected to
in 2011, compared with a decline of RM5.9bn estimated for 2010. Consequently, the record a surplus in 2011
country’s foreign exchange reserves will likely increase to US$103.7bn by end-2011,
from an estimate of US$94.9bn at end-2010.

The build-up in foreign exchange reserves will continue to provide an underlying We expect the ringgit to
support to the ringgit. As it stands, the ringgit has already turned around and fluctuate at around
strengthened against the US dollar in recent months. Between 18 June and 9 RM3.10-3.20/US$ for the
September, the ringgit appreciated by 4.4% against the US dollar, after falling by
rest of 2010, before
2.0% between 1 May and 18 June. Year-to-date, the ringgit has appreciated by 9.9%
settling at RM3.10/US$ in
against the US dollar, the strongest gain in the region. This was due partly to the
2011
improving sentiment over regional currencies, after China said that it would adopt a
more flexible exchange rate on 18 June. A widening interest rate differential in
favour of Malaysia versus the US, after Bank Negara Malaysia raised its key policy
rate three times and by a total of 75 basis points this year, also helped. The liberalisation
of administrative rules on foreign exchange transactions by the Central Bank on 18
August and the move by China to add the ringgit to a small group of currencies that
are allowed to be traded directly against the renminbi on 19 August further boosted
the ringgit. Before the addition of the ringgit, the only few currencies with that privilege
were the US dollar, pound sterling, yen, euro and Hong Kong dollar. The news sent
the ringgit to a near 13-year high of RM3.1288/US$ on 19 August, before easing back
slightly the next day. Also, the ringgit has been pushed up by the inflow of “hot
money”, which has risen to a 2-year high. As the “hot money” could come and go at
anytime, we expect the ringgit to remain volatile and will likely fluctuate at
around RM3.10-3.20/US$ for the rest of 2010. Going forward, we expect the
ringgit to settle at RM3.10/US$ in 2011.

Change In Administrative Pricing Will Lead To Higher Inflation

Inflation rate picked up to 1.9% yoy in July, from +1.7% in June and a low of Inflation rate picked up to
+1.2% in February (see Chart 10). This was the fastest rate of increase in 14 months the fastest pace in 14
and the fifth consecutive month of rising, due partly to the removal of fuel and sugar months in July
subsidies in mid July by the Government and partly the lower base effect given that
inflation contracted by a larger magnitude in the same month last year. As a result,
the core inflation rate inched up to 1.4% yoy in July, after remaining stable at 1.2% in
the last three consecutive months. This was attributed to a pick-up in the costs of
transport, which accelerated to 2.0% yoy in July, from +1.3% in June, on the back of
the increase in fuel prices by around 3%. A pick-up in the costs of housing, water,
electricity, gas & other fuels; and recreation services as well as prices of alcoholic
beverage & tobacco and furnishing & household products worsened the situation.
Similarly, the prices of clothing & footwear and the costs of communications fell by a
smaller magnitude during the month. In the same vein, food & non-alcohol beverage
prices grew at a faster pace of 2.9% yoy in July, compared with +2.7% in June and a
low of +0.8% in October last year.

Chart 10
Inflation Inching Up, But Not A Major Threat

% yoy
12
Core
10 CPI
8

6
➤

2
➤

-2

-4 Total
-6
05 06 07 08 09 10

ECONOMIC 11 OUTLOOK
Going forward, inflation is expected to increase at a faster pace due to the We expect inflation to
Government’s move to gradually reduce its subsidies once every six months that will trend up in 2011, due to the
lead to higher retail fuel and food prices. Already, the Government raised fuel prices reduction of subsidies
by around 3% and sugar price by 16.7% on 16 July. Our estimates showed that the
increase would add 0.2 percentage point and 0.08 percentage point respectively to
the CPI. This, together with some spill-over effect, will likely push up the CPI in 2H
2010 to around 2.6% yoy, from +1.4% recorded in the 1H. Further out, we expect
inflation to trend up to an average of 2.8% in 2011, from +2.0% estimated for
2010 and +0.6% in 2009.

Policy Normalisation To Resume In 1H 2011

Although the change in administrative pricing will lead to higher inflationary pressure, BNM will likely resume with
we believe Bank Negara Malaysia (BNM) will unlikely act on it. As it stands, its interest its policy normalisation and
rate hikes thus far were geared towards normalising monetary conditions in the the OPR will likely be raised
economy rather than controlling inflation. Indeed, we believe the Central Bank is
by 50-75 basis points in 1H
likely to have done with its interest rate hikes this year, after raising it by a total of 75
2011
basis points in three meetings and the OPR will likely stay at 2.75% until end-2010.
Further out, we believe the Central Bank will likely resume with its policy normalisation
and the OPR will likely be raised by 50-75 basis points in 1H 2011 to bring it to
a more neutral level of 3.25-3.50% by mid-2011.
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